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District Court Decision Regarding Size Status

On May 18, 2023, the U.S. District Court for the District of Columbia (the “Court”) issued a decision with potentially far-reaching consequences for small business federal contractors. The court’s decision held that utilization of merely tax returns for size certification purposes by federal contractors does not comply with the SBA’s regulations.

For False Claims Act purposes under which the action was filed, the Court determined that each of the defendant’s certifications regarding its size were false, in which the defendant excluded “flow-through income” from its size status certification. Instead, the court identified the SBA regulations’ size calculation as follows:

“Section 104(a) is best read as follows: The first sentence gives the baseline definition of receipts. Receipts are “all revenue . . . reduced by returns and allowances.” 13 C.F.R. § 121.104(a)The provision’s third and fourth sentences clarify that only the listed items may be subtracted from the baseline receipts total. See id. (“For size determination purposes, the only exclusions from receipts are those specifically provided for in this paragraph.”). The fifth sentence specifies some items that cannot be subtracted from receipts, including “reimbursements for purchases a contractor makes at a customer’s request.” Id. And, as the second sentence suggests, calculating receipts will often be as simple as adding “total income” to “cost of goods sold,” using a company’s “tax return forms.” Id. Finally, sub-provision (a)(1) states that when looking to tax returns, a company must use only those returns that they have already filed. See id. § 121.104(a)(1). Thus, § 104(a) provides a clear formula: receipts are “all revenue . . . reduced by returns and allowances,” and “the only exclusions from receipts are those specifically” listed in § 104(a). Tax returns may be used to calculate receipts, but they cannot override § 104(a)’s basic rules.”

In the action, the defendant described “flowthrough income” as “reimbursements for expenses incurred on behalf of and for the benefit of customers.” Yet § 104(a) directs that such money may not be excluded: “reimbursements for purchases a contractor makes at a customer’s request . . . may not be excluded from receipts.” The defendant did not argue that  “flowthrough income” is one of the listed items that may be removed. In sum, even if defendant could subtract “flowthrough income” on defendant’s tax returns, they could not do so when calculating their receipts.

The decision comes as a bit of a surprise as SBA and SBA’s Office of Hearings and Appeals (“OHA”) have long held that size status should be based on a concern’s tax returns, without more. But here, a U.S. District Court has held that SBA’s own regulations command a different result. The practical effect is that while SBA and OHA may continue to rely on their precedents, which authorize reference to a concern’s tax return, this decision does potentially create False Claims Act liability for federal contractors regarding their size status.

GCP is actively monitoring the effects of the decision and consulting with our strategic partners regarding next steps. At this time, we recommend that our clients review their financial records to determine whether they are still “small” under the Court’s reading of § 121.104. If you have any questions about this decision or your size status, please contact Trevor Skelly.